New Study Shows UK Workplace Pension Investors Should Avoid Default Funds
This month, as the UK’s auto-enrollment
HL’s study looked at the average 5-year returns that the 10 most popular fund picks of those who eschewed the default option achieved, compared to the default funds. The active fund pickers achieved average returns of 14.76% per annum over the period, while those who stuck with the default options’ average annual return was 9.9%. Over the entire period, that equates to those who took the time to pick their own fund boosting their pension pot by almost 25% more than their passive peers.
Auto-enrollment is the government’s answer to the UK’s pensions shortfall as the population ages. While the minimum state pension provision is expected to remain in place, it is already at a level in comparison to basic living expenses, which means pensioners who have no other source of income struggle to make ends meet. There are genuine concerns that the country’s finances will not be able to stretch to meet the pension needs of an ageing population as more of us live for longer and this gap will widen. Auto-enrolment was designed to ensure that everyone that has spent all or a significant portion of their working life will have a reasonable private pension provision to top up their basic state pension.
Under auto-enrollment, which while not obligatory is an opt-in rather than opt-out scheme for anyone earning over £10,000 per annum over the current tax year, both employee and employer pay a percentage of total earnings into a workplace pension fund. This year 1% comes out of the employee’s income and the equivalent to that 1% matched by the employer. By 2019, when auto-enrolment hits full stride, 5% will automatically come out of the employee’s earnings, with a 3% contribution made by the employer.
Every employer works with a private pensions provider of their choosing, from a list of government-approved suppliers, such as Scottish Widow, Prudential or Aviva, to name a few examples. The provider offers members of the auto-enrolment scheme a choice from a range of pension funds that contributions can be made into. The funds will always be considered relatively low risk but still over a risk range within the classification.
Employees who are beginner investors and don’t feel they have the knowledge or experience to differentiate between the funds on offer for their auto-enrolment contributions, almost always stick with the default fund. Of the 43.5 million members now signed up to workplace pension schemes, a staggering 92% have remained in the default fund.
It looks as though the 8% who have taken the time to assess and choose from the other funds on offer are doing considerably better out of their auto-enrolment pension pots. However, one important point to make is that the default fund options are conservatively managed and towards the lower end of the risk range covered by the range of funds that can be chosen from. That means that they are designed to both generate reasonable returns when markets are doing well but also minimise losses during downturns. Over the past five years markets have been enjoying a bull run and it is logical to expect that conservative funds will do well but less well than those with a slightly higher risk profile. However, in a market dip a more conservative fund would be expected to perform better. As such, those in default funds, while they should certainly assess their options, could well see the imbalance the Hargreaves Lansdowne study has highlighted even out over a longer test period than 5 years.
This article is for information purposes only.
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